The State of Reform: Dodd-Frank at Two Years Old

It was two years ago this Saturday that President Obama signed the Dodd-Frank financial reform into law. The landmark legislation — which clocks in at more than 2,000 pages — was meant to rein in a financial system that brought the economy to the brink of collapse in 2008. But push-back from industry lobbyists and Republicans in Congress has kept key aspects of the law from taking effect.

To date, just 123 of the 398 total regulations established under Dodd-Frank have been implemented, according to a tally by the law firm Davis Polk (PDF). Moreover, regulators have missed more than half of the rulemaking deadlines set out for them in the law.

On the eve of Dodd-Frank’s second anniversary, here is a closer look at how some of its most critical components have played out so far:

Consumer Financial Protection Bureau

The Consumer Financial Protection Bureau was one of the more controversial elements of Dodd-Frank, and it took a recess appointment by President Obama to get the agency’s first director, Richard Cordray, in office this past January. Housed inside the Federal Reserve, the new federal agency is charged with policing abusive lending practices geared toward consumers.

Earlier this month, the agency announced its first major initiative: an overhaul of the home mortgage industry with the goal of making it easier for borrowers to understand what kind of loan they are getting, as well as its true cost. On Wednesday, the bureau also announced its first enforcement action, a $210 million fine against Capital One Bank for what it called “deceptive marketing tactics.”

Volcker Rule

It has been a bumpy road for this cornerstone of financial reform. Named after former Federal Reserve Chairman Paul Volcker, the Volcker Rule bars banks whose deposits are federally insured from making proprietary bets — that is, making trades for their own benefit.

The proposed rule has been met by fierce resistance from industry lobbyists, who argue it would crimp one of their most lucrative lines of business and increase risks for clients. In recent weeks, supporters have bolstered their case for the rule by pointing to a botched trade by JPMorgan that has to date cost the bank $5.8 billion. Still, the JPMorgan case has underscored a key sticking point of the Volcker Rule: how to distinguish between proprietary trading and bets made to hedge against potential losses.

The rule was supposed to be finalized by the two-year anniversary of Dodd-Frank, but with some 17,000 public comments still under review, officials have signaled that a final draft will not be ready until September. Once it is, banks will have two years to comply, the Fed announced in April.

Healthier banks

In addition to higher capital requirements for banks, Dodd-Frank requires the nation’s largest financial firms to undergo annual stress tests to see how they would weather a major shock to the economy. The stress tests, which are run by the Fed, apply to any FDIC-regulated institution with more than $10 billion in assets. Specifically, officials want to see if banks would have enough capital on their books to survive a bevy of gloomy conditions, such as a peak unemployment rate of 13 percent, or a 21 percent drop in housing prices. In March, the Fed announced that 15 of the nation’s 19 biggest firms had passed the latest round of stress tests.

To avoid future taxpayer bailouts, banks are required to submit living wills to show regulators how they could be safely broken up in the event of an emergency. Earlier this month, the Fed posted wind-down plans for the first nine of an eventual 125 firms required to participate.

Derivatives

Remember all of those credit-default swaps and mortgage-backed securities at the heart of the 2008 meltdown? Both are a type of derivative — essentially a financial product that derives its value from something else.

The market for derivatives is valued at $700 trillion, but reforming this fairly opaque market remained a stalled effort until earlier this month when regulators approved a series of rules designed to make the industry more transparent. Moreover, the newly announced rules are due to set in motion nearly 20 related elements of Dodd-Frank over the next two months.

Most notably, regulators at the Commodities Futures Trading Commission finalized a definition (PDF) of exactly what qualifies as a “swap.” Firms that deal in swaps, as defined by the CFTC, will now have 60 days to register with the regulator. In announcing the definition, the CFTC also voted to require banks with more than $10 billion in assets to trade their swaps through regulated clearinghouses, which essentially serve as a backstop in case one party in a trade defaults.

At the same time, regulators carved out a series of exemptions to the new rules for small banks. The exemptions also apply to commercial firms that use derivatives to hedge against swings in the value of goods they purchase or manufacturer. Airlines, for example, trade in swaps to protect themselves from fluctuations in the cost of jet fuel. Bart Chilton, a Democratic member of the commission, criticized the exemptions, saying they created loopholes that the financial industry will be able to exploit. “One man’s loophole is another man’s livelihood,” Chilton said.

Financial Stability Oversight Council

If the Wall Street meltdown proved anything, it was how problems at a single financial giant can rapidly spread and put the entire financial system at risk. The job of the Financial Stability Oversight Council is to identify threats and encourage market discipline. Headed by Treasury Secretary Timothy Geithner, the 10-member council has authority over banks with more than $50 billion in assets. It will also for the first time put large nonbank financial institutions, such as hedge funds and private equity firms, under the supervision of a single regulator. The council is still determining exactly which nonbank firms it will monitor, but has said it will begin its evaluation by looking at institutions with more than $50 billion in assets, and either $20 billion in debt, more than $3.5 billion worth of derivative liabilities, or excessive leverage ratios.

The Durbin Amendment

In the days before Dodd-Frank, merchants would pay banks roughly 44 cents every time they processed a debit-card transaction. The Durbin Amendment, named for its author, Illinois Sen. Dick Durbin (D), changed that by setting a new cap on those fees of 21 cents per transaction. The rule was meant to aid retailers, who in turn, would pass the savings onto consumers. The change, however, has meant a loss of roughly $8 billion in revenue for big banks, and that has resulted in fewer rewards programs and new fees for many banking customers.

Credit rating agencies

The three major credit rating agencies — Fitch, Moody’s, and S&P — each saw their credibility take a hit following the crisis after it became clear that many of the mortgage-backed securities that they rated so highly were actually worthless.

In June, the SEC opened its new Office of Credit Ratings, as required under Dodd-Frank. The office will centralize oversight of the ratings agencies, and conduct annual examinations of their performance.

But other steps to reform the rating process have so far fallen short, including breaking a compensation model in the industry that allows companies to pay the very firms issuing ratings on them. Regulators have also struggled to implement a measure designed to break the financial system’s reliance on ratings.

For additional assessments of Dodd-Frank, explore The FRONTLINE Interviews, our oral history from Money, Power and Wall Street.

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